Breadcrumbs

Why nice people commit fraud

28 January 2021

Could kind, well-liked leaders be putting their company at greater risk of financial fraud than very aggressive leaders?

Groundbreaking new international research from the University of Waikato suggests that may be the case.

The study, ‘Why financial executives do bad things’ is co-authored by professors of accounting Jake Rose and Ania Rose. It was recently published in the Journal of Business Ethics, which ranks in the Financial Times’ Top 50 journals.

The research challenges the accepted wisdom about why financial executives decide to commit fraud, how the tone set by top management can influence their behavior, and whether wrongdoing typically escalates over time, from harmless to serious acts.

The study also questions whether external auditors fully understand the risk factors for fraud, or if further training is needed to improve the prevention and detection of fraud globally.

“The extent of financial misreporting is shocking,” says Professor Jake Rose, who is ranked the world’s #1 researcher (BYU Rankings) in the field of experimental accounting information systems.

“In any given year, some research suggests there could be a 15% chance that each publicly listed company has significant fraud happening," he says.

“And it's estimated that worldwide, companies lose more than US$3.5 trillion dollars every year - or about 5% of all corporate revenue -  as a result of financial fraud, so this is a major problem," says Professor Rose.

The role of financial executives is to accurately report a company’s financial information. But financial executives, such as controllers, are commonly involved in financial frauds.

Does aggressive management increase the risk of financial fraud?

The University of Waikato study investigates the longstanding assumption that financial fraud is more likely to flourish in workplaces where management adopts an aggressive tone, where employees feel pressured to meet revenue targets and fear top management.

For example, before going bankrupt in 2001, Enron’s corporate culture was characterised by a gruelling performance evaluation culture implemented by the company’s president.

For this study, more than 130 accounting controllers from the USA and the Netherlands completed an experiment where they were asked to make a decision about manipulating their firm’s earnings, and their Chief Financial Officer (CFO) was described as either very kind and non-aggressive or very unkind and aggressive.

Surprisingly, the research found that controllers were at least twice as likely to manipulate accounting figures when their Chief Financial Officer’s perceived tone towards employees was kind and positive.

By contrast, controllers who perceived their CFO’s tone as aggressive were significantly less likely to engage in financial misreporting, “and data indicates this happened because they didn’t feel an emotional connection or devotion to the company, so they had little incentive to help the company manipulate its earnings,” says Professor Rose.

“Fraud is not always committed by bad, immoral people for personal gain,” says Professor Rose. “Our research suggests that financial misreporting may instead be a form of misplaced virtue by employees who really like and respect their superiors. They wish to help their leaders and their company succeed, and sometimes misrepresenting earnings is perceived as a method for positively influencing stock prices and helping the firm succeed,” he says.

Testing the ‘slippery slope’ theory

The University of Waikato study is also one of the first in the world to test the ‘slippery slope’ theory. This is the idea that financial fraud begins with people engaging in small misdeeds due to pressure from top management, which gradually escalates over time into serious criminal wrongdoings.

Again, the results of the study run counter to expectations. It found that when the CFO’s tone is negative, controllers who have already started to violate minor rules are actually less likely to escalate and commit more serious offences than are other controllers who have not yet committed any wrongdoing at all.

“In other words, a very aggressive CFO can be more successful than a kind CFO in constraining the likelihood of financial fraud in some cases, and the slippery slope theory fails to explain such results,” says Professor Rose.

Failure of systems to detect and prevent fraud

Professor Rose says there is also evidence that the very governance structures designed to detect and prevent financial misreporting often fail.

In fact, only four percent of all fraud cases are actually detected by external auditors, according to a 2018 survey by the US-based Association of Certified Fraud Examiners (ACFE), the world's largest anti-fraud organisation.

This very low rate of fraud detection could be partly due to auditors making false assumptions about employees’ true motivations for unethical misreporting behavior, says Professor Rose.

To test this, the University of Waikato study also examined whether more than 90 auditors from the United States would perceive a greater level of fraud risk in a company when the CFO’s tone was aggressive and unkind; or if told that financial executives had violated a minor rule.

It found that auditors were not significantly concerned about minor rule violations or CFOs with a positive tone, but they were extremely wary of CFOs with a negative tone towards employees.

“Importantly, this means that auditors perceive that kind CFOs deter fraud, and our results suggest these beliefs could cause auditors to fail to detect many cases of fraud,” says Professor Rose.

“There appear to be great opportunities to improve fraud detection with very simple changes to auditor training and further research to test current assumptions about the causes of financial fraud.”


Latest stories

Related stories

University of Waikato partners with local iwi to build leadership support in schools

Dr Rachel McNae's award-winning expertise placed her in perfect stead to win a national grant…

Shipping containers

Modelling international trade regulations reveals hidden impacts

New Zealand recently signed the Regional Comprehensive Economic Partnership (RCEP), an historic trade agreement between…

Hon Grant Robertson

Tumultuous Times: National economics forum to ask the big questions

The University of Waikato is set to host a national economics conference on 3 and…

Dr Aydin Berenjian

Waikato researcher working on miracle vitamin that could lower Covid mortality

A University of Waikato researcher is working on a type of Vitamin K that could…

Earth’s magnetic field broke down 42,000 years ago and caused massive sudden climate change

The world experienced a few centuries of apocalyptic conditions 42,000 years ago, triggered by a…

Waikato marine scientists uncovering secrets to healthy estuaries

University of Waikato PhD students are carrying out important research into New Zealand estuaries in…

Waikato research identifies crucial role of education in supporting refugee and immigrant children

In 2016, UNICEF warned of the growing global crisis for refugee and immigrant children. Today,…

Newly promoted academics

New Professorial Appointments for Waikato

University of Waikato Vice-Chancellor Professor Neil Quigley has announced academic promotions for one new Professor…

Curb population growth to tackle climate change: now that’s a tough ask

Population growth plays a role in environmental damage and climate change.

Waikato computer scientists revolutionise the car parking experience through AI

AI experts from the University of Waikato continue to make the lives of everyday New…

Pou Temara, Mark Bowden, John McIntosh, Mike Sutton

2021 New Year Honours list recognises Waikato achievements

A former University of Waikato staff member and four alumni have been recognised for their…

These coastal wetlands are located a few miles north of Lincoln City, Oregon, USA.

Earth to reach temperature tipping point in 20-30 years, new study finds

Earth’s ability to absorb carbon emissions through plants could be halved within the next two…